Wells Fargo (WFC, Financial) is a terrific investment because it is one of the strongest, best-run banks. It operates with a conservative outlook by only engaging in businesses with low risk and constantly reducing expenses where practical. Wells Fargo also has some of the lowest cost deposits which is a competitive advantage in the banking industry. There are many growth initiatives that will add tremendous value to Wells Fargo's current profit base that are not factored in to today’s share price.
Wells Fargo has an unbelievably risk averse business model. It earned 48% of its revenue in Q4 2014 in non-interest income. This is very high and allows it to report excellent results. Other banks suffer more due to low rates that have been reducing the net interest income that is typically a larger portion of its revenue. In the 2008-2009 Great Recession, Wells Fargo had such high quality of operations that it was able to buy Wachovia, a large failing bank, while most of its competitors were suffering major losses. As of Q4 2014, Wells Fargo already has an 11.04% Common Equity Tier 1 to total Risk Weighted Assets ratio under Basel III (General Approach). This means that Wells Fargo already has sufficient capital to meet the regulatory requirements while some other banks are finding they need to raise and/or retain more capital.
Source: https://www08.wellsfargomedia.com/assets/pdf/about/press/2015/fourth-quarter-earnings-supplement.pdf
Currently interest rates are so low that deposits yield very little currently. Wells Fargo has historically had a lower cost of deposits than its competition but this has been muted the last few years because most banks have lowered their deposit interest rates near 0%. When interest rates rise, it is likely that Wells Fargo will regain some of this competitive advantage or it will grow deposits much faster than its competition. Wells Fargo was able to pay lower rates for its deposits in the past because of the company’s excellence in keeping its customers happy in other ways. This included having a high branch density so customers didn’t need to travel as far to get to their bank and cross selling additional banking services that customers might want.
Wells Fargo has lots of room to grow. Banks typically operate with an approximately equal amount of loans and deposits, sometimes even with 10 or 20% more loans than deposits. As of Q4 2014, Wells Fargo had $862.8 billion of loans and $1168.3 billion of deposits. This means that Wells Fargo has tons of room to grow its loans without needing deposits for funding. Wells Fargo is already paying the interest costs for the excess deposits without feeling the benefit of receiving interest from loans. As Wells Fargo makes more loans, the interest income earned by the bank will increase and this will increase profits.
Source: https://www08.wellsfargomedia.com/assets/pdf/about/press/2015/fourth-quarter-earnings-supplement.pdf
Wells Fargo has a risk averse business model with high non-interest income that was able to make a large acquisition during the Great Recession. It has historically had interest rates lower than its competition because it keeps customers happy. There is lots of room for future loan growth without adding deposits which will create a lot of value. These are the reasons Wells Fargo is an excellent investment.
